LLP Member or Employee? Dual status not possible

December 4, 2015

If there are employee members in your LLP, a recent case means you will need to decide whether those members are employees or members. Deciding which status is appropriate may be a relatively easy decision to make, but the consequences of moving from a dual status to a single status arrangement may be less straightforward.

In a general partnership (where there is no separate legal entity), it has been clear that one cannot be both a partner and an employee because no-one can employ himself. By contrast, an LLP does have separate corporate identity and, until recently, most took the view that it was possible to be both an employee and a member of an LLP.

The purpose of Section 4(4) Limited Liability Partnerships Act 2000 was to set out how to decide if someone is a member or an employee but it has always been difficult to interpret. However, the consensus view had been that it permitted a person to be both. Given this consensus, many LLPs adopted a class of employee/member or salaried member as the first step to an individual becoming a full self-employed member.

Determining the status of such individuals has now become important, following the recent High Court case of Reinhard v Ondra LLP & Others 2015, in which it was ruled that it is not legally possible to be a member of an LLP and an employee of an LLP at the same time.

The status of the many people engaged by LLPs as employee members now needs to be decided, with each person being clearly categorised as either a member or employee. The distinction between member and employee has important consequences, including in respect of employment rights, so clarity as to the rights which apply is important.

How to choose a statusThe guidance from the Reinhard case indicates that if the LLP and employee member cannot agree which status applies, a court would first review whether the objective intention of the LLP and the employee member was to give the employee member dual status. If that was the intention, then the court will review all of the competing terms of the arrangement to find whether “the substance of the rights and obligations of the parties overall” fits more closely with the individual being a member or an employee.

Where, as part of the arrangements, the employee member has no rights or obligations in relation to important factors of membership, such as capital contribution, profit share and voting rights, a court is likely to decide that the competing terms indicate an employment relationship. Where, as in the Reinhard case, the employee member is entitled to a share of the LLP, this is more likely to indicate a relationship as a member.

Clarify the TermsOnce the status has been agreed, that may not be the end of the story. The precise terms of the arrangement may need to be agreed. An employee member may have signed up to an employment contract, side letter and/or members’ agreement. Some terms may be applicable to employees only whilst other terms may only apply to members and some terms may apply to both employees and members. This may cause uncertainty as to which particular terms the parties are bound by once the status is agreed.

Where the status is determined to be as a member, the court would give effect to the employment provisions of the arrangement as contractual entitlements or obligations as a member (even though the origin of those rights was statutory). Where the status is determined to be as an employee, it seems that the court would interpret the rights and obligations as a member to give equivalent rights and obligations as an employee. Complications can still arise however. For example, if one of the rights was for the individual to have a vote on certain specific matters in his capacity as a member, would this be treated as a continuing right as an employee? Where these difficulties could arise, it makes sense for both the LLP and the individual to reach agreement on how the respective rights will be treated in the new status.

Dismissal before status is agreedDismissal may be an option for an LLP to take in order to ensure which status applies for the future. The LLP may want to dismiss the employee member completely, i.e. as both employee and member, before the sole status is agreed. To do so, the LLP will need to dismiss under both relationships in accordance with the separate rules for employees and members unless the existing contract specifically provides for interdependent dual termination. For example, an existing contract may provide that if the employee member is dismissed as an employee he will also cease to be a member. That provision may be ineffective if the status is decided to be as a member and not as an employee.

Avoid future uncertaintyIf you have an agreement that purports to create dual status, then consider rewriting the agreement to choose a single status, rather than face uncertainty and potential legal disputes. If the matter does escalate to litigation, the courts/employment tribunals will have to undertake the laborious task of assessing, on the facts, which single status the individual holds. The tax status of an individual will not be determinative, although more weight may be placed on this factor now that LLPs have consciously to meet or fail certain tests in relation to the tax status of members.